Putting February in Perspective

Posted On March 3, 2018 By Scott Stratton, CFP(R), CFA In Behavioral Finance /  

2017 was not only a great year in the market, but an anomaly of historic proportions for its extremely low volatility. There were no large daily swings in 2017, and no big drops or corrections regardless of the economic data, corporate earnings, or political turmoil. The market never fell below the January 1st level in 2017, so the year-to-date numbers were positive for the entire year.

This January continued 2017’s winning streak, but February was another story altogether. The market plunged roughly 10% in a week, including the largest single day point drop in the history of the Dow Jones Industrial Average. The market regained much of its loss, but has sold off by 3% or so in the past week. Investors are wondering is whether this is the end of the bull market and what to do next.

Here is the frustrating reality about being an investor: No one can predict the future. Forget about Wall Street forecasts – their track record of accuracy is horrible. The market doesn’t care what we think, positive or negative. The old saying that “the market climbs a wall of worry” has certainly been true the past year or two.

If you would have asked me at the start of 2017 if I thought the S&P 500 Index would go up 22% that year, I would have said no way. The prices were relatively high, we faced rising interest rates, and the political climate was a mess. Uncertainty is not supposed to be the backdrop for a 20%+ year.

Thankfully, I did not act on my opinions in January of 2017 and get out of the market, because we would have missed a tremendous year of investment returns. We should recognize that even when we think our feelings about the market are based on a rational examination of facts, there is no guarantee that the outcome will be as we expect. We are too easily influenced by recent performance and allow our fear or greed to drive investment decisions about what should be a decades-long plan.

For those who are disturbed by February’s action, I’d suggest taking a 30,000 foot view. Although the market did correct by 10%, we basically only gave up the gains from a few weeks and put accounts back at the level they were in December. The market pulled back towards the 200-day moving average, a key level of support, but did not cross or violate those levels. In other words, the overall trend upwards has not been broken. Perhaps the market just needed a correction and chance for profit-taking. That’s healthy and not necessarily a bad thing.

The US economy looks strong, and while the stock market could diverge from the economy, I think we can take comfort in knowing that wages are rising, unemployment is very low, earnings are growing, and many companies are robust and profitable. The tax cuts going to corporate America will increase earnings. Although we’ve gone nine years without a bear market, we are in unprecedented times, so it is possible that the market continues up for a while longer.

I share this not because I think my job is to be bullish or to convince people to buy stocks. Rather my objective is to educate investors, moderate our behavior, and encourage consistency. When fear starts to pick up, that’s the time when it becomes challenging to stick to the plan. Our focus should be on looking out 10 or 20 years. That’s the sort of time frame we really need to have in mind as an investor.

Just like the seasons, there will be a bear market – a drop of 20% or more – in the future. But investors would be better served by worrying less about the inevitability of market cycles and instead focusing on what they can control: how much they save, diversifying, keeping costs and taxes to a minimum, and having a long-term strategy.

We will continue to watch the market closely and evaluate whether a temporary correction threatens to become a more prolonged decline. If that were to occur, we would take action. For some investors, we may choose to become more defensive. For those with a longer time horizon, I think you want to buy when the market is on sale. This decision would be based on technical indicators – what the actual price movement of the stock market suggests – rather than a decision influenced by news, market sentiment, forecasts, or opinions. (We will explore this topic in more detail in an upcoming post.)

Presently, there is little from February to indicate that we’ve had anything more than a garden variety correction. Volatility is a normal part of investing, something we need to remind ourselves after 2017. If you’re not currently investing with us, let’s talk about how you are currently positioned and see if we might be able to recommend some ways to improve your investment strategy.

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Mid-Year Report: The Return of Irrational Exuberance?

Posted On July 2, 2017 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

We’ve passed the mid-year point and the market has had a strong performance in the first half of 2017. Investors should be very pleased with the results of the past six months, although I believe there are reasons to be guarded going forward. Our portfolio models all notched positive returns, but our value oriented approach held back returns relative to our benchmarks.

Looking first at stocks, our global equity benchmark, the MSCI All Country World Index (iShares ticker ACWI) produced a total return of 11.92%. That would be a great return for the whole year, and it’s only July 1 as I write this. US Stocks, such as the Russell 1000 Index (iShares ticker IWB) were up 9.15% in the first half.

Across the board, international stocks were well ahead of US Stocks, with both Developed and Emerging Markets producing 15% returns for the first half. Our International and Emerging small caps did even better, over 17%. Our positions in foreign equities were strong contributors to our portfolio returns. If you are just investing in domestic stocks, you really missed out so far in 2017. And International stocks remain less expensive than US stocks by most measures.

Our holdings in US Value stocks lagged, gaining only 2-4% versus the 9% of the overall market. Last year, Value outperformed both Growth and Core by a wide margin. For 2017, a handful of technology companies are dominating returns, specifically the so-called FAANG stocks: Facebook, Apple, Amazon, Netflix, and Google (now called Alphabet).

While these companies continue to post exciting growth, the price of these stocks is now incomprehensible to me. It feels like 1999 all over again, when there was no price too high for growing tech leaders. While I think that today’s top stocks are bonafide companies with genuine earnings, I still can’t justify the price of the shares.

It smells like a bubble to me, although limited to this small number of stocks. Now that doesn’t mean that we are necessarily on the verge of a collapse. Indices could continue to go higher from here, and even if a few high flyers do get clipped, that doesn’t mean that the rest of the economy will be in trouble.

Our investment process favors patience. We focus our portfolios towards the cheaper segments of the market which have lagged. We look for reversion to the mean, investing as contrarians, rather than chasing momentum. Our value funds and REIT ETF had positive returns, but were detractors from performance, as was our allocation to Alternatives. However, I remain committed to these positions because they are relatively cheap. While they did not beat the market over the past 6 months, our rationale for holding them has only grown more compelling.

In fixed income, the US Aggregate Bond Index (iShares ticker AGG) was up 2.40% year to date. Our fixed income allocations were ahead of AGG by 30 to 80 bps, with higher yields and lower duration. Our position in Emerging Market bonds was a standout performer for the half. I continue to keep a close watch on high yield bonds, but overall think we are well positioned for today’s economy and potential future rate hikes.

I write about the markets twice a year, and not more frequently, to not distract us from sticking to a long-term allocation. We focus on what we know works over time: diversification, keeping costs low, using index funds for core positions, and tilting towards value. Our discipline means that we don’t let short-term events pull us away from our strategy.

Looking at the first half, our fixed income and international equity holdings did quite well. Our value and alternatives holdings have not yet had their day in the sun. However, if the market does eventually realize that the US tech stocks have gotten “irrationally exuberant”, I think we will be glad we have our more defensive positions.

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Adversity or Opportunity?

Posted On October 21, 2014 By Admin In Behavioral Finance /  

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In the past two weeks, market volatility has spiked and major indices have traded down 7% or more.  I follow the market closely and monitor the situation for news which might impact our portfolios.  Generally, I prefer to use this space to discuss beneficial financial planning topics, but I know that everyone is wondering about the market, so here is my take on the situation.

The recent pull-back has been relatively minor and probably long-overdue, given that we’ve gone five years since a significant correction.  The good news is that stock fundamentals are strong and the US economic recovery remains in place, although actual growth is somewhat tepid. While equity prices have risen, valuations are within a normal range and not at the elevated levels we saw in previous bubbles.  With interest rates remaining extremely low, “risk” assets like stocks still offer greater potential return than cash or fixed income.

Having shared my opinion, I have to say that it really doesn’t matter what I think will happen.  Anyone who thinks that data is “proof” of what the market is going to do is fooling themselves.  No one can predict the market.  Fortunately, long-term investment success does not require a crystal ball.  What it does require is a well-researched and executed plan, a diversified allocation, and most importantly, the fortitude and discipline to stick to your plan.

I was asked this week if I got my clients out of the market before the recent turmoil.  No, I didn’t and I didn’t sell any of my own stock positions, either.  I was doing the opposite this week: buying in a number of portfolios.  And I was quite happy to have the opportunity to pick up ETF shares 5-10% lower than they cost just three or four weeks ago.  I’m focused on the long-term opportunity and not the present adversity.  Although I don’t know where the market will be one month from now, I strongly believe that the market will be significantly higher in 10 years from now and that is what really matters.

So rather than worry about the troubles of the day and the things you cannot control, I believe investors are best served by focusing on the things you can control, such as:

  • establishing a target asset allocation to match your risk tolerance, required return, and time horizon;
  • diversifying to eliminate company-specific risks;
  • keeping investment expenses low and reducing tax drag to a minimum; and
  • how much you save and invest.

Of these four, the last one is crucial to your individual success.  The news tends to make us focus on trying to improve short-term investment performance, instead of how much you should be saving.  If your goal is accumulation, it’s more important to be thinking about how to increase your saving than how to increase your return.  We have to learn to ignore the noise of the daily media so we can stay focused on how to achieve our long-term objectives.

Optimism is key.  Not a blind naivete, but the confidence to know that you are on the right path, and the recognition that sometimes the path is uphill. I remember a bit of wisdom I heard years ago “You make your money in bear markets, you just don’t know it until later.”  If you’ve got five or more years to retirement, you should welcome each pullback in the market as a tremendous opportunity.

With this understanding, there are some small ways to take advantage of the recent market turmoil and use the recent drop in prices to your advantage:

  • Put excess cash to work; if you haven’t made your IRA contribution, now is a good time.
  • Rebalance your portfolio.
  • Swap losing positions to harvest tax losses; replace your high expense funds with tax-efficient, low cost ETFs.  Use the downturn as an opportunity to clean up your portfolio.
  • Add Emerging Market equities, if you don’t have any.  EM is down more than domestic equities and has lagged for several years.

Market timing may be an alluring mirage, but ultimately is a counterproductive distraction for investors.  If you’re able to take advantage of the pullback, that’s fine, but if you’re already invested, don’t think that you have to “do something”.  Most of the time, doing nothing is ultimately the best option!

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